FedEx Seen Caught in Shipping Shift as Cheap Trumps Quick

The driver for an independent contractor to FedEx Corp. delivers packages in San Francisco, California. Photographer: David Paul Morris/Bloomberg

Sept. 19 (Bloomberg) -- FedEx Corp.’s falling volumes for
its fastest, most-profitable services signal that shippers are
increasingly deciding their packages no longer have to be there
overnight -- and not just in a slowing economy.

The operator of the world’s largest cargo airline may be
seeing a more permanent change in its market, as customers turn
to cheaper, slower ground deliveries and even ocean shipping.
It’s an evolution that threatens to touch United Parcel Service
Inc. and Deutsche Post AG’s DHL Worldwide Express, too.

“There has been a secular shift from ‘got to get it there
overnight’ to more deferred products,” said Jeff Kauffman, a
Sterne Agee & Leach Inc. analyst in New York. “Not because they
can’t afford it, but because they are finding out the deferred
choices are just as time specific.”

FedEx spotlighted the strains on its business yesterday
when it cut its full-year profit forecast, sending the shares to
their biggest drop since June 1. Quarterly volumes fell for
premium delivery services in the U.S. and overseas, as shippers
chose cheaper alternatives to having their goods packed onto jet
freighters, the Memphis, Tennessee-based company said.

Chief Executive Officer Fred Smith pioneered the modern
air-freight industry as he took an idea in one of his college
essays and built it into the company he runs 41 years later.
FedEx Express, the biggest unit, uses planes to expedite
deliveries of goods ranging from electronics to pharmaceuticals.

‘Absolutely, Positively’

“When It Absolutely, Positively Has to Be There
Overnight” became a pop-culture catchphrase starting in the
1970s as FedEx featured the trademarked slogan in ads
emphasizing speed and reliability.

Now FedEx is under pressure from forces as varied as the
economic slowdown in the U.S. and overseas and what Kauffman
said is a growing number of customers that have never used
overnight deliveries. Three- and four-day services meet many
businesses’ needs, Kauffman said in an interview.

“You’re seeing a demand for slow instead of a demand for
fast. That’s a structural change,” said David Vernon, a Sanford
C. Bernstein & Co. analyst in New York. “You either create a
service that takes more of that volume shift or you end up in a
much worse position.”

FedEx will use an Oct. 9-10 investor meeting in Memphis to
detail changes at FedEx Express that will take out “a
significant amount of cost,” Smith told analysts yesterday on a
conference call. He didn’t elaborate, and Jess Bunn, a
spokesman, declined to comment beyond what was said on the call.

Market Transition

“This is an acknowledgment that the market that FedEx
built its business on in the ’80s and ’90s has changed,” said
Ben Hartford, a Robert W. Baird & Co. analyst in Milwaukee.

The company said in August it would offer voluntary buyouts
as part of its savings plans. FedEx also is retiring 24 jet
freighters and 43 older engines to match shipping volumes. It
has said it expects to stop using 21 Boeing Co. 727s and replace
them with more fuel-efficient 767-300 and 757-200 aircraft.

FedEx rose 0.4 percent to $86.90 at the close in New York
after yesterday’s 3.1 percent drop. Gains of 4.1 percent for
FedEx and 1.5 percent for UPS this year trailed the 16 percent
advance for the Standard & Poor’s 500 Index.

Kauffman recommends buying FedEx, while Hartford has an
outperform rating on the stock and Vernon rates the shares as
market perform.

China Fallout

Contracting economies in the U.S. and Europe have triggered
a slump in international trade growth over the past several
months, contributing to a drag on shipping demand and hurting
economic growth in China, Smith said yesterday on the call.

“The locomotive that has driven China’s growth is its
export industries, and with the situation in Europe and to a
lesser degree in North America, that is a significant issue for
the Chinese economy,” Smith said. “The consumer consumption in
China is not increasing at a significant rate, contrary to
everybody’s hopes.”

At the same time, FedEx has been adjusting product
offerings, including expanding sea freight offerings through
FedEx Trade Networks as that shipping business has grown. FedEx
is an “increasingly big player in that segment,” Smith said.

Volume Drop

Volumes among all categories of domestic shipments fell in
the quarter from a year earlier. A cell-phone company that FedEx
declined to identify shifted from all-Express shipments during
the quarter to a combination of ground and SmartPost, a service
for low-weight residential shipments in which the U.S. Postal
Service provides final delivery.

Donald Broughton, an Avondale Partners LLC analyst based in
St. Louis, said he believes the demand shift at FedEx is based
on slowing economic growth, not a structural change within the
shipping industry.

“In a slowdown, that’s what happens,” he said. “People
cut back on costs. But when the economy rebounds, price matters
less as volumes take off.”

The changes noted by FedEx will extend to UPS and DHL, said
Broughton, who has a market perform rating on FedEx and a market
underperform on UPS, and doesn’t cover Bonn-based DHL parent
Deutsche Post. UPS pared its annual profit forecast in July
after second-quarter earnings trailed analyst estimates.

Global ‘Triopoly’

Michael Mangeot, a spokesman for Atlanta-based UPS, said
“trade down” has been an issue in recent years as customers
have tightened budgets. Domestic air volumes at the world’s
largest package-delivery company have risen in recent quarters,
he said.

DHL didn’t return a telephone message seeking comment
yesterday.

Dell Inc. is among the companies changing shipping
preferences as its business changes.

To save money, the Round Rock, Texas-based maker of
personal computers is trying to sell more units with preset
configurations instead of tailoring each PC to order. That saves
money and allows Dell to send more cargo by sea instead of
relying on costlier air service to ensure timely deliveries.

“Our ocean shipments year-over-year grew 60 percent,”
President Jeff Clarke told analysts on a June 13 conference
call. A spokesman, David Frink, declined to give a breakdown
yesterday on the ocean-instead-of-air shift.

“Customers looking to save cost in a low-growth economy
are moving toward deferred products,” said Anthony Gallo, a
Baltimore-based analyst for Wells Fargo Securities LLC who rates
FedEx as market perform. A long-term market transition is under
way as well, he said in an interview.

“Shippers think differently about how they move
products,” he said. “If your supply chain is predictable, then
transit times are somewhat less important, as long as it shows
up when it’s supposed to show up.”